The Role of Uninformed Investors in an Optimal IPO Mechanism, or What Google Did Right and Facebook Did Wrong

Abstract

This paper explores optimal ways for a firm to sell its initial public offering (IPO) to a mix of informed and uninformed investors through an intermediary. The informed investors are assumed to behave as an "exclusive club" by colluding to protect their private information about the IPO value. I argue that uninformed investors' profit provides a benchmark for informed investors, resulting in an endogenous constraint that affects the issuer's revenue. I conclude that higher revenues are achieved with higher numbers of uninformed investors participating in an IPO. Furthermore, the intermediary serves as the only credible provider of information about uninformed investors' realized demand to informed investors. This increases the issuer's expected revenue, and provides a rationale for substantial commissions paid to the intermediary. The above implications could be stylistically interpreted in the context of IPOs by Google and Facebook.

Keywords: IPO, Uninformed Investors, Optimal Mechanism, IPO Intermediation, IPO Underwriter

JEL Classification: G24